Two institutions plain to issue $10 million in debt and are negotiating an interest rate swap...

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Two institutions plain to issue $10 million in debt and are negotiating an interest rate swap that will help them lower their borrowing costs and obtain the preferred type (fixed rate or floating rate) of financing. Both are comparing their balance sheet alternatives with combined balance sheet and swap opportunities. Bank Morgan has a negative GAP through three years, is liability sensitive, and would like to use the debt proceeds to invest in short term assets to reduce its interest rate risk. Bank Salem has a positive GAP through three years, is asset sensitive, and would like to use its debt proceeds to invest in fixed assets to reduce its interest rate risk. Bank Morgan can borrow at 4.7% fixed rate for three years or pay the prevailing six-month LIBOR plus 1 percent on floating rate debt. Bank Salem can borrow at a 4.15% rate for three years or the prevailing six-month LIBOR rate plus 0.50%. (a) Explain whether and why Bank Morgan and Bank Salem needs fixed rate or floating rate funding to meet its objectives. Two institutions plain to issue $10 million in debt and are negotiating an interest rate swap that will help them lower their borrowing costs and obtain the preferred type (fixed rate or floating rate) of financing. Both are comparing their balance sheet alternatives with combined balance sheet and swap opportunities. Bank Morgan has a negative GAP through three years, is liability sensitive, and would like to use the debt proceeds to invest in short term assets to reduce its interest rate risk. Bank Salem has a positive GAP through three years, is asset sensitive, and would like to use its debt proceeds to invest in fixed assets to reduce its interest rate risk. Bank Morgan can borrow at 4.7% fixed rate for three years or pay the prevailing six-month LIBOR plus 1 percent on floating rate debt. Bank Salem can borrow at a 4.15% rate for three years or the prevailing six-month LIBOR rate plus 0.50%. (a) Explain whether and why Bank Morgan and Bank Salem needs fixed rate or floating rate funding to meet its objectives.

Answer rating: 100% (QA)

a Bank Morgan and Bank Salem have different objectives and interest rate risk profiles which will de... View the full answer